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Growth or Value: Which ETFs Have an Edge Ahead of Elections?

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The battle between growth and value investing has been heating up this month.

Election uncertainty coupled with a sharp decline in technology stocks and a new wave of COVID-19 globally unnerved investors in recent weeks. Additionally, lofty valuation, lack of additional fiscal stimulus package, fight over a Supreme Court nominee to replace Justice Ruth Bader Ginsburg, allegations of money laundering against big banks, concerns over fresh lockdowns measures, and rising U.S.-China tensions added to the chaos (read: 4 Safe ETF Bets as Global Stocks Tumble).

Wall Street’s growth stocks including Apple (AAPL - Free Report) , Google-parent Alphabet (GOOGL - Free Report) , Amazon.com (AMZN - Free Report) and Tesla (TSLA - Free Report) bore the brunt of the broad market rout. These were among the biggest winners of the stock market rebound from the lows hit on Mar 23. As such, the tech-heavy Nasdaq Composite index, which primarily comprises growth stocks, has been underperforming this month so far, having lost 9.7% compared with a decline of 7.5% for the S&P 500 and 5.8% for Dow Jones.

In fact, the benchmark entered into a correction territory (down 10% from the latest peak) last week. The drop in these stocks suggests that growth investing has lost steam in the absence of a vaccine and more stimuli. iShares Russell 1000 Growth ETF (IWF - Free Report) , which targets the growth segment, plunged 8.4% in a month, compared with a decline of 5.3% for its value counterpart iShares Russell 1000 Value ETF (IWD - Free Report) .

Growth Vs. Value

Growth stocks refer to high-quality stocks that are likely to witness revenue and earnings increase at a faster rate than the industry average. These stocks harness their momentum in earnings to create a positive bias in the market, resulting in higher share prices. As such, growth funds tend to outperform during an uptrend. However, these stocks have comparatively higher P/B, P/S and P/E ratios and exhibit a higher degree of volatility especially compared to value stocks (see: all the Large Cap Growth ETFs here).

Value stocks have strong fundamentals — earnings, dividends, book value and cash flow. These stocks trade below their intrinsic value and are undervalued by the market. These seek to capitalize on inefficiencies in the market and have the potential to deliver higher returns with lower volatility compared to their growth and blend counterparts. Additionally, value stocks are less susceptible to trending markets and their dividend payments serve as safety in times of market turbulence. Notably, these stocks outperform the growth ones across all asset classes when considered on a long-term investment horizon (see: all the Large Cap Value ETFs here).

The current market turmoil has led to strong inflows in some big value ETFs. iShares MSCI USA Value Factor ETF (VLUE - Free Report) and Vanguard Value ETF (VTV - Free Report) pulled in about $900 million in capital each this month, followed by inflows of $600 million each for Vanguard Small-Cap Value ETF (VBR - Free Report) and IWD. At the same time, few growth ETFs like Vanguard Growth ETF (VUG - Free Report) and Vanguard Small-Cap Growth ETF VBK also saw strong inflows of about $1.4 billion and $900 million, respectively. On the other hand, the ultra-popular Invesco QQQ (QQQ - Free Report) , which is focused more on growth stocks, has bled $1.3 billion in AUM so far in September.

What’s in Store?

While value ETFs have accrued $1 billion in inflows over the past month, according to CFRA Research’s First Bridge Data, growth ETFs are expected to outperform as we head into elections. “With interest rates staying low for the foreseeable future and a cyclically strong quarter ahead, funds such as the iShares S&P 500 Growth ETF (IVW - Free Report) and VUG are poised to climb and resume their lead over value.”

The analyst at CFRA recommends being overweight on the information technology and communications services sector for the growth part but also having strong positions in the health-care and consumer staples sectors as defensive plays (read: Time for Tech is Back: 5 Low P/E ETFs to Play).

Investors should note that growth ETFs are inclined toward technology, consumer discretionary and communication services stocks while value funds are focused on financials, healthcare and industrials stocks. Therefore, for value to outperform, technology should fall out of favor relative to financials. As technology valuations have increased to elevated levels after more than a decade of outperformance, some correction was due. But the outlook for the sector remains bright with rising demand for e-commerce, cloud computing, artificial intelligence, gaming, e-sports, and streaming services.

On the other hand, the financial sector remains unattractive due to lower rates and ongoing pandemic, which has led to slow economic recovery (read: 4 Sector ETFs to Benefit From 3-Year Lower Rates).

Overall, growth ETFs are the outperformers from the year-to-date perspective, braving all the hurdles. IWF is up 18.2% versus a decline of 14.7% for IWD.

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